How might the South be helped by Northern technology yet harmed by Northern money?

Abstract

This paper highlights a prominent yet neglected feature of North–South trade, namely that the Northern currency is used as the medium of exchange. It investigates how this feature may affect the way real and monetary shocks are transmitted from the North to the South through trade. It shows that technological progress in the North benefits its Southern trading partner. However, if Southern consumers need to hold Northern money to pay for imports, a monetary expansion in the North hurts the South. In particular, it increases the demand for Northern money in the South, which has to be met by a transfer of real resources from the South to the North. This has an adverse effect on the terms of trade for the South and on the trade balance for the North. This last result is supported by our empirical analysis which shows a positive correlation between US money supply and US bilateral trade deficits with Mexico and with India.